As part of the audit reform agenda, there has been broad acknowledgement that the definition of a Public Interest Entity (PIE) needs reform. This definition lies at the core of government’s proposals for corporate governance and audit reform as it determines which entities are included in it. The contention lies in what that looks like; the BEIS whitepaper outlines changes that could more than double the number of entities that are considered PIEs while simultaneously significantly extending the regulation that applies to them.
It suggests broadening the scope so that some large private companies meet the definition of a PIE. Option one sees private companies with more than 2,000 employees or a turnover higher than £200m and assets above £2bn classed as PIEs. Under option two, it’s companies with over 500 employees and a turnover of more than £500m. AIM businesses with market capitalization over €200m and Lloyds syndicates would also be PIEs. The government asks if ‘third sector’ entities should also be included. This would reclassify thousands of businesses as PIEs.
The major issue with this is that the market for accountancy talent may not have the capacity to handle this many PIEs. It raises the question of whether there are enough skilled professionals in the market to staff all the PIE audits, prepare their accounts and fill newly created roles at an enlarged regulator – and what other work in the economy will have shortages as a result. Mergers and acquisitions is one area that has strong demand from the same talent pool.
“I am genuinely concerned, if the government's proposals about extending PIEs lead to a doubling of the entities being brought into the system, the entire ecosystem of audit, assurance and regulation will just simply topple over,” says Iain Wright, ICAEW’s Managing Director, Reputation and Influence. “Government will not get what it wants, in respect of securing additional assurance that key companies are governed and audited well.
“The supply of appropriately qualified and experienced personnel for both auditors and the regulator will not match the demand created by such an extension, certainly in the medium term. In trying to meet demand, firms may suck in talent and capacity from smaller audit firms, putting in jeopardy the audit of smaller companies, which is such a strong means of improving company performance, resilience and assurance across the UK.”
There is also another factor, Wright explains. Evidence from Europe after audit reform in 2016 suggests that many firms, when faced with the extra time and work required to audit PIEs, will decide that they don’t want to be in the market at all. “The Netherlands saw the withdrawal of quite big firms from the PIE market after reform. That runs completely counter to the Government’s wishes to see more competition and choice in the audit market, certainly at the large company end.”
Capacity is not the only issue that the PIE reforms could dredge up. There are questions, for example, on how well the reforms would work for public sector entities. Under the proposals, HS2 would not count as a PIE, despite the clear public interest around it. Conversely the Student Loans Company would be classed as a PIE. Which has the greater public interest?
The whitepaper itself also poses critical questions about the public sector and PIEs: whether universities and charities should be brought into scope as well, considering the potential detrimental impacts should one collapse. The current criteria are broad, but still limited, says Wright. They catch thousands of additional businesses where the public interest case might be quite weak, while missing others where there would be a clear public interest if they were to fail.
“It's not just about quantitative elements, but about qualitative elements. That’s what is needed in order to produce a definitive list of what constitutes a significant company acting in the public interest.”
There is also a potentially missed opportunity to remove some listed companies with little risk in their accounting and may not need to be directly monitored and supervised by ARGA. This may work as a trade-off for taking the better-defined public interest audits.
While the number of employees is an important metric to determine whether an entity is a PIE, there could be more focus around important sectors for the UK economy, or the organisation’s connection to a local community, or where the effects on their supply chain would be so vast that it would have a knock-on effect on many businesses, livelihoods and communities.
“Redcar was a proud Steeltown until the steelworks went under in 2016,” says Wright. “The knock-on effect of that on local employment and the supply chain across the north of England was profound. Big steel plants are invariably important to the local community. Wouldn’t it be appropriate to bring that into scope? It was foreign-owned, which adds a little complexity, but it’s a good example of a business that wouldn’t fit the crude quantitative criteria but would meet qualitative ones. At the same time, the proposals would catch some coffee shop, bookstore and gym chains – are these really in the public interest?”
This is not about saving ailing businesses, stresses Wright; the economy will continue to shift and innovate. But what it could protect against is unexpected failure. “You can't stop failure, but for those most important businesses, you need to be able to clearly see the early warning indicators.”
With the UK out of the European Union, audit reform gives the nation a chance to create a set of criteria for PIE that closely matches the structure and interests of the UK economy. The current proposals don’t do this, but it’s not too late to create a methodology that does. “It’s another timely opportunity to shape the sort of regulatory and inspection framework to reflect what the country needs,” says Wright.
Restoring trust in audit and corporate governance
‘Restoring trust in audit and corporate governance’ is the BEIS white paper that sets out proposals on strengthening the UK’s corporate governance framework and the way companies are audited. Read ICAEW’s views on the consultation, explore what restoring trust means, and share information on the reform agenda.